Here’s what spooked the Fed from raising interest rates

Federal Reserve Chairwoman Janet Yellen speaks at the University of Massachusetts

WASHINGTON (MarketWatch) — Turmoil in the stock market and concerns about China were pivotal in the Federal Reserve’s decision to keep interest rates near zero, minutes from the last meeting released Thursday show.

In light of this, officials decided it would be “prudent” to wait for more data to confirm the economy was growing at a moderate rate and labor market conditions had improved further.

“Many expected those conditions to be met later this year, although several members were concerned about downside risks to the outlook for real activity and inflation,” the minutes said.

The rise of the dollar was especially troubling because exports were still being held down by the rise in the dollar’s value in 2014, Fed officials said.

U.S. stocks
SPX, +0.32%
initially surged, and then leveled off, after the release of the Fed’s minutes.

Fed officials have said since the beginning of the year that they would raise rates when labor markets had improved further and when they were confident inflation would move up to the 2% target.

At the September meeting, some Fed voting members said their confidence that inflation would return to 2% “had not increased” since the July meeting “in large part because recent global economic and financial developments had imparted some restraint to the economic outlook and placed further downward pressure on inflation in the near term.”

Millan Mulraine, deputy head of U.S. Research and Strategy at TD Securities in New York, said in an interview this confidence was not likely to increase at the Fed’s last two meetings of the year.

Sal Guatieri, senior economist at BMO Capital Markets agreed: “It may take more than a few months to gain this confidence.”

Most thought that their goal of healthy labor market had been met or would be met by the end of the year. That view may be different now that the September jobs report, released after the Fed meeting, showed slowing growth.

In the end, the Fed voted 9 to 1 to hold rates steady in September. Richmond Fed President Jeffrey Lacker was the sole dissent in favor of a rate hike.

The minutes show both hawks and doves were putting pressure on the moderate center of the Fed policy committee at the meeting.

The doves warned that hiking rates too soon would only push inflation lower.

The more hawkish members were concerns that delaying hiking rates “much longer” would lead to an unwanted buildup of inflation pressures. They thought the announcement of a rate hike might provide a signal of confidence in the strength of the U.S. economy.

Officials took pains to stress that the drop in stock prices before the meeting was only important as far as it impacted the U.S. central bank’s forecast for jobs and inflation.

The minutes reveal that Fed officials discussed when to stop reinvestment of securities that mature from its large balance sheet. No decisions were taken. The Fed staff said studies made it seem like it didn’t matter if the central bank took this step soon after the first rate hike or decided to wait. But continuing to reinvest securities until rates were well above zero could help if there was an unexpected adverse shock.

The Fed staff was notably more downbeat than their bosses.

The minutes show the staff forecast was weaker than at the prior meeting at the end of July even though most economic indicators were above expectations.

While the staff’s forecast for growth in the second half of this year was unchanged, the staff lowered its projection for economic growth “over the next several years” as a result of the market turmoil and the stronger dollar. The staff also thinks inflation would remain below the Fed’s 2% target even at the end of 2018.

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